The ECB’s bazooka/ Gold rising on misunderstood fundamentals

Basically all assets were buoyed by the ECB’s bazooka, a plan to load up unlimited amount of troubled country’s debt, since last Thursday. I have to admit that my assessment regarding “no open-ended commitment from the ECB” (See rationale here) was wrong and hence I missed the rally in the past few days.

With the one-sided rising asset prices in the past few days, I spot some upward movements in certain assets were unjustified, and gold (silver as well) is one of the assets that rose on a misunderstood fundamental.

The ECB’s bazooka, a.k.a. Outright Monetary Transactions (OMT), is a plan to remove certain “tail risks of  Euro breakup” with the details listed below:

1.          Purchases of sovereign bonds maturing in 1 – 3 years in the secondary market

2.          No quantitative limits are set on OMT

3.          No subordination of private investors

4.          Full Sterilization

5.          Conditionality of OMT is attached to EFSF/ESM program

Indeed, OMT is enough to build a firewall to safeguard the too-big-to-fails (Spain and Italy) as long as those countries comply with austerity measures (Of course, austerity will mean a recession for them). OMT, in my opinion, has several implications to the market:

l   Removing a Lehman-like re-denomination risks in Europe in the intermediate term (until a blowup of the ECB)

l   Increasing recessionary risks for countries under OMT, just like the Greece and Portugal which carried out austerity measures under the current Trioka plans

l   The total liquidity in the euro system will stay unchanged given the full sterilization structure

I think the Operation Twist (OT) by the Fed which was firstly launched in Sep 2011 and then extended in Jun 2012 was a good example in explaining the term “sterilization” and its impact on asset prices.

As I covered here few months ago, sterilization is hardly supportive to commodity prices (incl. precious metals).  This is also the reason why gold peaked at US$ 1,900 last September and trended down to recent low at US$ 1520 in Q2 2012 despite the crisis in Europe kept worsening.

If OMT really means less crisis, no money printing and higher chance of recession in Europe, I don’t see the reason why the “safe-haven”, “money-printing-sensitive” gold could rise as much as, if not more than,  equities, Euro or others assets that benefit from the removal of tail risks in Europe.

While some investors are arguing gold will rise as the Fed will carry out QE 3 on 13^th Sep FOMC meeting to match what the ECB did last Thursday, I am holding my breath to see what will happen otherwise.

I am particularly interested in the movement of gold in Euro (XAUEUR) if QE 3 doesn’t become reality this week. A dramatic fall for this pair is likely to happen: 

Source: Reuters, click to enlarge